In this episode of The Proskauer Benefits Brief, Proskauer partners Ira Bogner and Adam Scoll and law clerk Tanushaproskauer benefits brief podcast Yarlagadda discuss the Department of Labor’s final ESG rules issued on November 22, 2022, and how those rules affect the consideration by ERISA fiduciaries of environmental, social, and governance or “ESG” factors when making investment decisions and exercising shareholder rights, such as voting proxies.  Although these final rules generally became effective on January 30, 2023, they are currently being challenged both in the courts and in Congress.


 Listen to the podcast

 

Tanusha Yarlagadda: Hello and welcome to The Proskauer Benefits Brief: Legal Insights on Employee Benefits and Executive Compensation. I’m Tanusha Yarlagadda, a law clerk in the firm’s Boston office, and I’m here with Adam Scoll, a partner in our Boston office, and Ira Bogner, a partner in our New York office.  Today we will be discussing the Department of Labor’s final ESG rules that were issued on November 22, 2022, and how those rules affect the consideration by ERISA fiduciaries of environmental, social, and governance or “ESG” factors when making investment decisions and exercising shareholder rights, such as voting proxies.  These final rules generally became effective on January 30, 2023, except for certain proxy voting-related rules we will discuss later in the podcast, which will not take effect until December 1, 2023.  The rules are, however, being challenged both in the courts and in Congress as we will note later in the podcast.  Ira, why don’t you start us off by giving us a 50,000 foot view of how these final rules compare to the Trump administration’s 2020 regulations on the same topic?

Ira Bogner: The final rules are intended to be more supportive of ERISA fiduciaries considering ESG factors in investment decisions as compared to the 2020 regulations. Although the 2020 regulations did not specifically refer to “ESG” considerations, they distinguished between “pecuniary” and “non-pecuniary” factors, creating a perception that any consideration of ESG factors, even factors considered to be financially material, could expose ERISA fiduciaries to liability.  The final rules provide some comfort that ESG considerations are not completely off limits, but the underlying principle that risk and return cannot be sacrificed has not changed.  Adam, do you agree?

Adam Scoll: Thanks Ira, I agree.  Although the final rules are warmer to ESG considerations than the 2020 regulations, the final rules retain ERISA’s bedrock principle that an ERISA fiduciary cannot sacrifice investment returns or assume greater investment risk to promote collateral objectives.  Like the 2020 regulations, the final rules preserve the long-standing requirement that a fiduciary give “appropriate consideration” to the facts and circumstances that the fiduciary knows or should know are relevant. The final rules go on to provide that “appropriate consideration” may include the economic effects of climate change and other ESG factors on the particular investment, but do not prohibit or in all cases require such consideration.  So, the Final Rules eliminate the distinction between “pecuniary” and “non-pecuniary” factors, and instead provide that a fiduciary may consider any factor material to the risk/return analysis, including climate change and other ESG factors.

Tanusha Yarlagadda:  The final rules also simplify a “tie-breaker” concept that has historically been included in Department of Labor guidance by making it easier to use ESG or other “collateral benefits” as a “tie-breaker” between competing investments. Now, instead of limiting a tie to a case where the applicable investments could not be distinguished based on “pecuniary factors” alone, the final rules define a tie as competing investments that “equally serve the financial interests of the plan over the appropriate time horizon”.  Also, the final rules eliminate the special documentation and disclosure requirements for a tiebreaker and instead apply the same documentation and disclosure principles as for all other investment decisions.  Ira, can you highlight for us the changes under the final rules affecting participant-directed plans, such as a typical 401(k) or 403(b) plan?

Ira Bogner:  Sure.  The 2020 regulations prohibited a fund, product, or model portfolio that expressly considered ESG factors to be used as a Qualified Default Investment Alternative or QDIA under a participant-directed plan.  However, the final rules do not include such a prohibition or any other special ESG-related rules with respect to QDIAs – QDIAs are treated just like any other investment option.

The final rules also include a new clarification that a fiduciary of a participant-directed plan does not violate the duty of loyalty solely because the fiduciary takes into account participants’ preferences when setting the plan’s investment lineup. Nonetheless, the clarification does not change the duty of prudence, which still turns on an analysis of risk and return characteristics (without regard to what participants might want).  It is important to note that the final rules do not mandate that fiduciaries factor participants’ preferences into their decision-making, nor do they prescribe a methodology to account for such preferences.

Tanusha Yarlagadda: Thanks, Ira.  It is also important to note that the final rules do not include a “safe harbor” for a fiduciary to treat ESG-themed funds as a separate asset class.  Accordingly, ESG-themed funds must be evaluated relative to other alternatives in the particular asset class, and fiduciaries could be exposed to potential claims if an ESG-themed investment option underperforms its benchmark.  To mitigate risk, fiduciaries should carefully document the reasons for their investment decisions relating to investment options, including, in the case of an option with an emphasis on ESG factors, the relevance of ESG considerations to risk and return objectives. The final rules also made changes with respect to proxy voting.  Adam, why don’t you walk us through those?

Adam Scoll:  Sure.  The final rules retain the core principle that a fiduciary’s responsibility with respect to investment management includes the management of appurtenant shareholder rights, such as voting proxies.  Driven by a concern that the 2020 regulations could discourage proxy voting activity by plan fiduciaries, the final rules remove the 2020 regulations’ proxy voting safe harbors, as well as the statement that ERISA does not require the voting of every proxy, while acknowledging that a fiduciary may determine on a case-by-case basis that voting of a proxy is not in the plan’s best interests.  The final rules also eliminate burdensome recordkeeping requirements and underscore that proxy voting is a key tool in managing investments in issuers that should be taken seriously by ERISA fiduciaries.  The Final Rules also remove special monitoring obligations for delegated proxy voting rights and advisory services, and special recordkeeping requirements regarding proxy voting activities.

Ira Bogner:  Right.  The final rules also continue to allow plan fiduciaries to establish investment policies that cover proxy voting, and they require investment managers of pooled “plan asset” funds to reconcile conflicting policies of participating plans to the extent possible.  This could require that the fund manager exercise shareholder rights of the fund (voting or abstaining) in proportion to each plan’s economic interest in the fund. Alternatively, the fund manager may develop its own investment policy statement that is consistent with Title I of ERISA and require participating plans to accept that investment policy statement, including any proxy voting policy, before they are allowed to invest (or in order to remain invested in the fund).  Although the final rules generally became effective on January 30, 2023, these particular rules related to proxy voting will not take effect until December 1, 2023.

Tanusha Yarlagadda: Any other key takeaways worth noting? 

Adam Scoll:  Yes.  Investment managers of separate accounts, private investment funds and other pooled investment vehicles that have contractually agreed to operate as if the fund, account or other vehicle were subject to ERISA or in accordance with the ERISA standard of care should consider whether any of these changes will or should affect their operations or investments. Also, while U.S. state “governmental plans” are not subject to ERISA, certain governmental plans are subject to rules that are similar to ERISA.  However, a number of states have proposed or already enacted legislation or other guidance that includes express prohibitions on the consideration of ESG and other “collateral” factors when making public plan investment decisions.  It remains to be seen how such state laws will be interpreted or applied.

Ira Bogner: Another item to note is that, as of March 13, 2023, legislation has been introduced by Congress that would nullify these final rules, and lawsuits have been filed in the Fifth Circuit and the Seventh Circuit challenging the validity of the final rules.  We will keep you posted on any new developments in this regard.

Tanusha Yarlagadda: Thanks, Ira and Adam. That concludes our discussion of the DOL’s 2022 final ESG rules. Thank you all for joining us on The Proskauer Benefits Brief.  Stay tuned for more legal insights on employee benefits and executive compensation, and be sure to follow us on Apple Podcasts, Spotify and Google Podcasts.

Print:
Email this postTweet this postLike this postShare this post on LinkedIn
Photo of Adam Scoll Adam Scoll

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard…

Adam Scoll is a partner in the Firm’s Tax Department and Private Funds Group.

He specializes in the area of Title I of ERISA and the investment of ERISA “plan assets,” advising both pension trusts and their investment managers and advisers with regard to compliance with ERISA’s complex fiduciary duty and prohibited transaction rules.

Adam regularly advises private investment fund sponsors regarding the structuring of their funds in order to accept investments from ERISA-covered pension trusts, including compliance with the ERISA “plan asset” regulations and the operation of venture capital operating companies (VCOCs) and real estate operating companies (REOCs).

Adam also represents both employers and senior executives in the negotiation and drafting of employment and separation agreements, deferred compensation plans, and equity and “phantom equity” arrangements, including compliance with the nonqualified deferred compensation rules under Sections 409A and 457A of the Internal Revenue Code.

Photo of Ira G. Bogner Ira G. Bogner

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of…

Ira G. Bogner is Managing Partner of the Firm. He is the immediate former chair of the Firm’s Tax Department. He is a member of the Employee Benefits & Executive Compensation Group and the Firm’s Executive Committee. Ira represents a varied list of clients, including financial service companies, entertainment industry clients, and tax-exempt organizations, and also actively represents individual executives in executive compensation matters.

Ira counsels clients with respect to the tax, securities law disclosure, corporate governance, stock exchange and other requirements relevant to executive compensation arrangements. Ira also provides advice regarding equity arrangements, employment agreements, change in control agreements and all other types of executive compensation arrangements, including guidance regarding “409A,” “162m,” “457A,” and “280G.”

Ira frequently is called on to structure and analyze alternative investments for pension trusts and other exempt organizations. He also works with the Firm’s corporate and real estate lawyers in structuring and maintaining investment funds that include participation by pension plans. Through his work in the investment fund area Ira has obtained substantial experience in applying the rules provided under the “plan asset” regulations, including the operation of venture capital operating companies and real estate operating companies. He has assisted in the formation of private equity, real estate, infrastructure and hedge funds, including “fund of funds.” Ira also has advised clients on both avoiding ERISA “plan asset” status and operating an investment fund in accordance with ERISA.

Areas of Concentration

Ira has provided guidance to clients on a wide variety of matters in the areas of employee benefits and executive compensation, including:

  • investment of plan assets
  • implementation of employee benefit plans

  • employee benefit issues in mergers and acquisitions

  • awarding of equity-based compensation

  • negotiation and drafting of employment agreements and severance arrangements

  • structuring, analyzing and maintaining investment funds that are suitable for plan investors

Thought Leadership

Ira has published a number of articles in publications such as The New York Law Journal, The New Jersey Law Journal, The Daily Deal, The Journal of Pension Planning and Compliance, Mergers and Acquisitions (The Monthly Tax Journal), The Journal of Taxation and Regulation of Financial Institutions, The Metropolitan Corporate Counsel, European Private Equity & Venture Capital Associations, The LPA Anatomised and Private Equity International and has been named to the Board of Advisors of the Journal of Taxation and Regulation of Financial Institutions. He also has lectured on topics such as the classification of workers, drafting employment agreements, equity alternatives for senior executives, investing IRA assets, the plan asset regulations, shareholder approval of equity plans, Code Section 409A, and key provisions for ERISA investors investing in a private equity fund.

Recognition

Ira has been recognized and ranked by various directories. US Legal 500 has carried the following comments: “Ira Bogner is ‘available, responsive and knowledgeable;” “Ira Bogner ‘provides a level of comfort with respect to business issues that is rare in the world of ERISA;” “Ira Bogner is the ‘go-to guy for fund sponsors needing help with ERISA.’”